Bond market crumbling? No, world still hopeful on US debt deal.

Bond market debacle seems unlikely, many foreign officials say. But bond market could see loss of America's Triple A rating if there are no big budget cuts long term.

ByEmily Kaiser, ReutersJuly 25, 2011

People react in front of an electronic stock board of a securities firm in Tokyo, Japan, July 22, 2011. World stock and bond markets did not panic July 25, 2011, as US lawmakers continued to squabble over raising the debt limit.

Shuji Kajiyama/AP

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SINGAPORE – Policymakers worldwide oscillated between hope and confidence on Monday that U.S. lawmakers will break a debt impasse that threatens to trigger a default and up-end global financial markets.

Asia, which holds close to $3 trillion in U.S. government debt, has a powerful vested interest in Washington finding a workable compromise. Policymakers and economists expected lawmakers would strike a last-minute deal to avert a crisis.

The political brinkmanship hit world stocks on Monday and pushed money into safe-haven gold and Swiss francs, ending a brief relief rally over Greece's second bailout package, although there was no sign of panic in stock or bond markets.

"Those in direct charge of reserves operations must be more nervous than before, but nobody thinks Americans will choose suicide when they have known solutions," said a senior official at the Bank of Korea, who spoke on condition of anonymity.

Fresh from pulling together a new bailout of debt-ridden Greece, Berlin also expected Washington would raise its debt limit.

"If you look at the world markets, they are jittery though they have not nose-dived," the Indian official said.

Australian Treasurer Wayne Swan said a protracted debt ceiling debate added uncertainty to the global economy.

"With the global recovery and confidence still fragile, it's in everyone's interests that U.S. policymakers work towards a speedy resolution," Swan said in an email to Reuters.

Congress has set the U.S. government's borrowing limit at $14.3 trillion, but the Treasury has already tapped that amount and needs more to meet its obligations. Republicans want an agreement on spending cuts before they authorise more borrowing. Democrats want to see a mix of lower spending and higher taxes.

Ratings agencies have warned that even if Congress raises the debt ceiling and averts a default, they may still strip the United States of its AAA credit rating, the highest possible, if lawmakers fail to agree on deeper long-term budget cuts.

A lower credit rating could raise borrowing costs not only for the U.S. government but also for other countries, companies and consumers because U.S. Treasuries are the benchmark by which many loans are measured.

U.S. Secretary of State Hillary Clinton, speaking in Hong Kong, said she believed Congress would secure a debt deal and "work with President Obama to take steps to improve our long-term fiscal outlook".

WHERE TO INVEST?

Ethan Harris, co-head of global economic research at Bank of America-Merrill Lynch, said he expected a temporary increase in the debt ceiling with the promise of up to $4 trillion in deficit reductions to be finalised six months later.

"The base case scenario can be summarised as 'appease and delay' -- appease the rating agencies and the market with the beginnings of a large plan, but in actuality delay the crisis further into the future," Harris said.

Robert Tipp, chief investment strategist at Prudential Fixed Income in Newark, New Jersey, said the U.S. Treasury may have a bit of wiggle room on the Aug. 2 deadline because tax revenues had exceeded expectations. But that would buy days, not weeks.

For Asian policymakers, there is no alternative to investing in U.S. Treasuries. China and Japan are by far the world's biggest foreign owners with more than $2 trillion in Treasuries combined. No other market in the world is deep enough to absorb that size of investment.